When a member becomes entitled to draw benefits from a registered pension scheme, they use up a proportion or percentage of their lifetime allowance. That is how the lifetime allowance test works, by reference to percentages of the individual’s lifetime allowance used up in particular circumstances.

There is no measure for lifetime allowance purposes of any benefits held by the individual until entitlement to those benefits arises. The exceptions to this rule are

where the member reaches age 75 without having taken benefits,

where the member transfers to a certain sort of overseas scheme, or

where certain payments prescribed in regulations are made, for example, after the member’s death because entitlement to those benefits for the purpose of the tax rules could not be established before the death.

In these cases any undrawn entitlement is tested for lifetime allowance purposes at that time.

In addition, where the member reaches age 75 having previously designated funds after 5 April 2006 in a money purchase arrangement as available for the payment of drawdown pension (known as unsecured pension before 6 April 2011), the amount by which the value of their drawdown pension fund at that time exceeds the value of the funds previously designated is tested for lifetime allowance purposes.

The circumstances where a lifetime allowance test occurs are referred to in the legislation as benefit crystallisation events (BCEs). At each BCE a capital value is attributed to the benefits that crystallise. This capital value (the amount crystallising) is converted into a percentage of the standard lifetime allowance for the tax year the BCE occurred in. That percentage is then measured against the member’s available lifetime allowance at the point of testing.

The percentage of the member’s lifetime allowance being used up as a consequence of a BCE is added to any percentage used up previously by the member, whether under the same scheme or a different registered pension scheme. Where the total of these percentages exceeds the individual’s lifetime allowance, the excess (or the chargeable amount) is subject to a specific tax charge (the lifetime allowance charge).

Example

Mike crystallises benefits with a capital value of £150,000. The standard lifetime allowance at that point is £1.5 million, so the percentage used up is 10%. If Mike had not crystallised any other benefits previously, he will have 90% of his lifetime allowance still available for the next BCE.

The same process occurs when Mike crystallises benefits at a future date.

This time Mike crystallises’ a further £450,000 when the standard lifetime allowance is £1.8 million. So Mike has used up a further 25% of the standard lifetime allowance. In total Mike has used up 35% (10% + 25%) of his lifetime allowance.

The percentage of the standard lifetime allowance used up at a particular BCE in a particular tax year remains constant year by year even though the standard lifetime allowance is changed in subsequent tax years. So the 10% of the standard lifetime allowance used up in the example above when the standard lifetime allowance is £1.5 million remains constant at 10% in the later year when the allowance has risen to £1.8 million. This process ensures that the original crystallisation amount of £150,000 maintains a fixed percentage, despite subsequent changes to the lifetime allowance.

RPSM11100040 explains the logic behind this process in more detail, and the example in RPSM11100090 illustrates this principle.

When calculating the percentage of the standard lifetime allowance being used up at any BCE the scheme administrator need only be concerned with the benefits currently being tested under their particular scheme. They do not require specific details of any other benefits the member may have (which in turn avoids the need to obtain details of other rights when the individual joins the scheme). However, in order to calculate whether the member has enough available lifetime allowance to cover the amount crystallising at that BCE (and whether or not a lifetime allowance charge is due) the scheme administrator may well require details from the member of the previous percentages of the ‘standard lifetime allowance’ they have used up under other registered pension schemes at earlier BCEs.

RPSM11103000 onwards explains in more detail the lifetime allowance testing process and the responsibilities imposed under the tax rules on each party.